I've written about Brazil pre-Lula and post-Lula and spent the last five years covering all aspects of the country for Dow Jones, Wall Street Journal and Barron's. Meanwhile, for an undetermined amount of time, and with a little help from my friends, I will be parachuting primarily into Brazil, Russia, India and China. But will also be on the look out for interesting business stories and investing ideas throughout the emerging markets.

Is Brazil A Fail?

Brazil has seen its better days. But for Brazilians, the good news is, they've seen much much worse.

Is Brazil’s economy a fail?

Well, for starters, higher incomes and 5.4% historically low unemployment suggests nothing of the sort. Brazil’s economy is growing nearly as much as the U.S., and without much stimulus.

But there are problems, at least with perception regarding what was once Latin America’s favorite, sexiest economy.

Admittedly, Brazil had a much better than average recovery after the 2008-2009 financial crisis, with both growth and investments coming in above average against its emerging market peers, notes Tony Volpon, head of emerging markets Americas for Nomura Securities in New York.

“This was due to two factors,” he says. “First, Brazil’s sensitivity to the huge improvement seen in China that greatly boosted the price of its commodity exports and the effects of the strong counter-cyclical policy response executed in 2009, with one eye fixed on the 2010 presidential elections.”

China spent trillions on stimulus when the U.S. economy crashed, driving up demand for Brazil’s key commodities, namely iron ore and soybeans. Then, in the last year of Workers’ Party president Luiz Inacio Lula da Silva, the Central Bank, marginally independent, kept interest rates artificially low. When he left office in 2011, his successor from the same party, Dilma Rousseff, was left with increasing inflationary pressures that new Central Bank leadership tried to tackle by using macroprudential measures that ultimately failed to deliver. Inflation rose. Interest rates were always behind the eight ball. With inflation like a runaway train, companies stopped investing.

“The reasons for this are many, but we would highlight the following sequence,” says Volpon, naming the effects of the policy tightening in 2011; the binding of supply-side growth constraints, especially full employment; the negative impact on business confidence and the highly interventionist policies pursued in 2012 like the intervention in the electricity sector that destroyed billions in shareholder value.

For instance, since Jan. 1, 2011, CemigCemig, one of Brazil’s most actively traded electric power ADRs in New York, is down a whopping 42%.

This year has seen a certain improvement in performance in corporate investments, but it remains to be seen whether this will have much momentum given that the only substantial change in economic policy has been to give the Central Bank greater freedom to hike interest rates. How this pans out in the 2014 election year is anybody’s guess, though it may be wiser to err on the side of rates not going as high as they could to fight inflation out of fear Dilma gets the boot. So far, Dilma has no serious challenger.

Brazil’s relative inflation performance has been consistently worse than its peers. The emerging market average is about 5%. Brazil is closer to 6%.

Higher inflation means higher costs for business and the general population, from food costs to education. For companies, inflation makes it harder for them to judge future prices or to price their goods and services. Inflation can get costly for companies who employ hedging strategies to lock in prices they might not have locked in if inflation was more predictable.

Granted, inflation goes up when the economy is hot. But Brazil’s inflation has been high even when GDP growth was low. This suggests that the growth/inflation trade off worsened in Brazil relative to its peers. One reason was supply-side constraints. The other reason was a worsening credibility gap at the Central Bank, something Volpon says occurred for his team at Nomura since the “surprise” August 2011 rate cut.

“Right now inflation performance is running relatively better than its peers, which is an encouraging signal even though actual inflation performance is being helped by repressed regulated prices,” Volpon said about electricity and gasoline prices, primarily. The government refuses to raise gasoline prices. PetrobrasPetrobras investors have been hoping for a price increase for around two years.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

Hi Ken, as usual I take an optimistic view. There a lot of factors at work that don’t appear in the official figures, primarily the black and grey economy here… from personal experience there is a lot of money flowing around the economy that isn’t counted in official numbers, a lot… There is a huge amount of cash payments and under-the-table business, especially amongst the Class C group. Also a lot of small businesses do work-for-work with other businesses.

It would be interesting to see an estimate of the black/grey economy integrated into the official figures to see what the economy is really doing…

Regarding easy of doing business. A policy announcement by Dilma that slipped through the news was a new online portal for opening and closing business in 5 days, based on the Singapore and New Zealand model. It’s planned for 2014 – before the election I imagine -.

I have a feeling the PT are going to refocus on the progressive urban middle class vote in the lead up to the 2014 elections. So I’d expect a few bones thrown in that direction over the next year…

the fundamentals for a developed country are NOT THERE. and everyone feels it. access to (ie cost) things (ie things) is one of the most difficult in the world. as a result, the competitiveness of the country and its people are falling behind.

but its this robustly obstinate attitude and the lazy ability to ignore the truth that is most prevalent in the country, and which keeps brazil from really flying.

the injustices, and the dinosauric thinking are too much for me to ignore.

so the big (and very simple) warning to anyone dealing with brazil is this: you have to check twice before believing the charm.

I spend a lot of time in Brazil, and the “on the ground” inflation numbers are significantly higher than what the government reports. Speak to any Brazilian or expat, inflation ain’t no 6%. Most Brazilians live in and around the big cities, and at R7000 per square meter, not affordable, even if it’s only a 50 sq mt box. Smart money left Brazil in 2009, going to USA in form of real estate cash purchases. We are talking multi million dollar cash purchases. On a buying power basis, dollar would need to be 4:1 for parity. Brazil had the opportunity to compete with China for global manufacturing, instead they chose to protect local business, therefore no incentive to improve quality and cost. Fat and happy. Brazilians used to say if USA catches a cold, we get the flu. Now they say, if China catches a cold, we get the flu. Sad.

Scott, I would say that Brazil has little choice but to maintain its protectionist policies. Protectionism is highly addictive to any economy, – hello European Common Agricultural policy or US farmer Subsidies, or even China – Brazil is still a developing economy and a sudden shock by reducing tariffs would result in mass unemployment within the manufacturing sector. The service sector simply isn’t mature enough to take up the slack and would collapse as its customer base melted away.

I realise free market economists and Freedman advocates detest the kind of policies that Brazil maintains, I’m no fan either, however Brazil’s number one problem is poverty, not cheap iPhones. Until there is a stable enough real middle class there is zero chance Brazil with “do a Russia” and use shock therapy. Brazil is a democracy, however dirty, and this would be unviable electorally and if implement result in massive social upheaval and possible something much worse than Brazil has now.

I don’t particularly enjoying paying a lot for average quality goods, or doing an annual shop in the US and lugging it back through the airport in Brasília, but until the wider economy is mature enough to handle a reduction in manufacturing jobs I’ll just have to wait because the alternative is much worse.

Luis, thank you for the thoughtful reply. Clearly you know more about your country than I, my opinions are that of an outsider. That being said, protectionism has been policy in Brazil for many years and unless the people demand it, will remain for many years to come. Those in power are not incentivized to change it. They can afford those trips to Miami, buy imported autos, grocery shop at Pao de Azucar. Like a heroin addict, the only way to stop is to go cold turkey. Here in the USA, we have addictions as well, and I believe that we need to take our medicine sooner than later. With the boom in Brazil, it would have been prime time to begin removing trade barriers so middle class people could begin to afford goods. That goes for proper infrastructure build out as well. Sure, building new roads and trains helps, but it has to become part of the way. As much as it hurts to have to have a set of plans approved by a zoning department, pay impact fees, etc., it makes for a better city and community. As you know, there has been a boom in building, a good thing, but at least in the city I frequent (Fortaleza), little attention to planning or infrastructure. Growth + poor planning, poor infrastructure, high taxation and high import tariffs = high cost of goods and services (i.e. inflation). You have to start somewhere. When Brazilians get really tired of buying a poorly built Celta for R30k, with a 12 month warranty, things will begin to change.

When I first came to Brazil, I invested my money in domestic financial products and received a monthly payment of 4-5% which I remember thinking was amazing. In reality the increase was more due to inflation than performance. I would argue that inflation has slowed since and the economy appears more stable today but, I completely agree, spending power here is abysmal. Take the hotel industry, for example. How can a country with comparatively such low wages generate a cost of 3 or 4 times the price of a better hotel room in the US? Is it taxes? Is it greed? Is it lack of demand? I’d love to know.